Mergers and R&D Investment: A Unified Approach

We investigate the impact of mergers on R&D incentives within a framework of R&D competition where effort can influence both the probability of innovation and the payoff conditional on success. Our framework nests the results of two classes of existing models and reveals assumptions that are restrictive. In models where R&D effort increases the probability of innovation but does not directly affect the payoff upon success, we show that the assumption of zero payoff upon innovation failure is restrictive. In models where R&D effort influences the payoff conditional on success, but not the probability of success itself, the assumption of deterministic innovation success (i.e., a success probability of one) is similarly restrictive. Across both modeling approaches, we offer a novel insight: the shape of investment costs, and by implication the pre-merger level of innovation, can be pivotal in determining whether a merger strengthens or weakens firms’ incentives to invest in R&D. In an extensions section, we further examine the role of R&D input and output synergies, firm asymmetries, as well as the implications for consumer surplus.